Governor of Eesti Pank speeks about the Estonian economy

Looking more closely at the Estonian economy, it can be seen that the growth in Estonia in 2014 came primarily from the domestic market, said Ardo Hansson, Governor of Eesti Pank in his speech to the Estonian Parliament on May 26, 2015.

  • Domestic consumption was lifted by rising employment, falling unemployment, and strong wage growth and a simultaneous fall in prices. The economy grew faster in 2014 than in 2013, but it should be remembered that no return to the growth rates seen in the boom years of the last decade is to be expected.
  • It may be hard to get used to the idea of lower growth rates, but economic truths cannot be denied. The Estonian economy and Estonian demographics are in a different phase of development now, and long-term sustainable growth is notably lower at 3–4%.

Consumer price inflation in Estonia fell below zero in June 2014 for the first time since the crisis. Four years ago prices fell across a wide range of goods and services, but last year the fall in prices was mainly caused by cheaper energy and food. Eesti Pank is not forecasting any rise in prices this year, but rising wages will put upward pressure on the prices of domestic goods and services.

One reason for the rapidly rising labour costs has been the decline in the working age population, but faster growth in wages than in productivity could endanger the competitiveness of the Estonian economy in the longer term. Companies are for now able to cover the rapidly rising labour costs from their profit buffers, but in the longer perspective this will inevitably cease to be possible. Reduced profits threaten the ability of companies to invest in higher productivity and in the human capital needed for more complex and higher-value work. I have often said, and it bears repeating again today, that the key challenge in the development of the Estonian economy is how more complex work than hitherto can be accomplished with a smaller workforce.

The rapid rises in wage income and household consumption boosted tax revenues in 2014, which in turn improved the state finances and helped lift the state budget to a small surplus in 2014. Going forward it is important that the government stick to the target agreed in the budget strategy of maintaining a nominal budget balance and building up its reserves.

  • Here I should note that the purchases of bonds by central banks and the resulting fall in interest rates have encouraged the belief or the conviction that there is a free lunch to be had and Estonia is denying itself a feed because the Estonian state does not issue bonds. We all know full well that there is no such thing as a free lunch. Even were the central bank to purchase one quarter of the bonds issued by the state, those bonds would still constitute a debt that would have to be paid back eventually.
  • Financing new investment through state bonds could well prove inefficient and harmful for the Estonian economy as a whole, even if the investments are in good projects. The low unemployment and rapid wage rises that we see at the moment would cause a large part of the extra money gained from the emission of state bonds to be lost, as infrastructure projects would cost much more than before. Large state construction projects that can only be temporary in nature would also cause economic and social problems in Estonia, because once the large projects finish, a great number of those working on them would find themselves unemployed, having left jobs in other sectors.
  • It must be understood that Estonia already profits from the purchases of bonds by the central banks of the euro area. Financial markets act as a series of communicating vessels, so that when interest rates in one area fall, the effect is passed on to other areas. The lower interest rates in the euro area mean that Estonian companies and households can borrow more cheaply, and were it necessary the Estonian state could also borrow more cheaply. If easier financing conditions spur on the European economy, Estonian exporters will be among the winners, and this is the goal towards which the bond purchase programme is striving.

In summarising the Estonian economy I should say our economy has grown at a satisfactory speed overall, as there is no little uncertainty in the global economy and there are protracted problems with growth in several of Estonia’s export markets.

  • The tensions in geopolitical relations last year, including the trade sanctions between the European Union and Russia, have left a mark on the Estonian economy, though fortunately not a deep one.
  • Estonian exporters deserve recognition for the flexibility they have shown in finding new markets. Exports have managed to increase even as prices have been generally falling in foreign markets, while local production costs have been driven up by rapidly rising wages. That the market share for Estonian goods and services in the trade with partner countries has increased shows that Estonian export items are competitive in international markets.

Source: Speech of the Governor of Eesti Pank to the Riigikogu at the presentation of Eesti Pank’s Annual Report 2014

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